The recent warning from the Treasury Borrowing Advisory Committee (TBAC) about a $1.45 trillion funding shortfall in fiscal 2027-28 has brought attention to the U.S. government's borrowing strategy and its potential consequences. While Scott Bessent, the Treasury Secretary, has been leveraging short-term bills to finance the annual deficit, this approach has its drawbacks. By focusing on cheaper rates today, the government is exposed to inflation and rising interest rates, as evidenced by the $120 billion increase in Treasury outlays this year. This strategy, however, is not new. It was initiated by Janet Yellen, Bessent's predecessor, who was criticized for 'activist Treasury issuance' by economists Stephen Miran and Nouriel Roubini. Now, Bessent is continuing this approach, despite the potential risks. The issue is further complicated by the collision between the Treasury and the Federal Reserve. As the Treasury leans on longer-term bonds, the Fed, under new Chair Kevin Warsh, is moving to shrink its balance sheet, which could lead to a decrease in buyers for long-term Treasuries. This situation raises concerns about the financial system's stability and the impact on mortgage rates, which are benchmarked to Treasury yields. The global financial system relies on Treasury debt as the 'collateral of last resort', and any cracks in this system could have far-reaching consequences. The U.S. government's debt is growing, and the problem is being deferred, but the long-term implications are uncertain. As Jon Hilsenrath, a veteran Federal Reserve watcher, warns, 'We are slowly boiling ourselves like a frog'. This metaphorical frog is the U.S. financial system, which may not be able to withstand the rising interest rates and inflationary pressures. The question remains: how will the U.S. government address this growing deficit and the potential risks associated with its borrowing strategy?
